What Is A Bear Market?

Answering the question "What is a bear market?" could clearly be very
quick and easy or shockingly complex! We have tried to offer a
conclusive bear market definition elsewhere. However, should you be hoping for a more in-depth discussion
of the complexities and impacts of bear markets, this is the page for
you!

Firstly, it is worth pointing out that recessions and
depressions are the causes of these stock market conditions. Business
and economic reality always - somehow - underlies market prices.

In his book, "After A Crash: Bear Market Money Making",
'Uncle' Harry Schultz describes some of the effects of the 21 bear
markets seen between 1900 and 1987. He describes the index as losing
between 13.9% and 90% in the different downward periods. Clearly, adding
these losses together totals an enormous amount of money.

He also
points out that these losses are for the index. Some stocks will have
moved very differently to the average, producing many differing results
for individuals. In addition, any stock market index typically tracks the biggest 'blue
chip' companies. These firms are likely to have lost far less value than
their smaller counterparts.

He adds that, "As a loose rule of thumb, you can say that historically most stocks lose half their value in the average bear market".

In other words, the damage that can be done to an individual investment portfolio is very significant.

This book is a real eye-opener and details the history of stock market bears until it's publication.

Some bear markets can be swift and over quickly. Hopefully, losses will soon be recaptured by a bear market rally. In "The Intelligent Investor",
Benjamin Graham says, "there were fairly important setbacks between
1949 and 1968 (especially in 1956-57 and 1961-62), but the recoveries
therefrom were so rapid that they had to be denominated (in the long
accepted semantics) as recessions in a single bull market, rather than
as separate market cycles".

In contrast, other bear markets have
ravaged economies. Sticking with the United States stock market for
examples, the Great Depression which began in 1929 saw massive losses in
the market. By 8th July 1932, the index was down a massive 90% from
it's all time high and stood at just 41.

In fact, according to
S&P's figures, the market fell so hard and the impact was so deep,
that in the period of 1924-49 the annual rate of growth was only 1.5%.
It wasn't until the early 1950s that the heights of 1929 were rescaled.

Obviously,
short-term recessions do not have the same impact, and there is some
correlation between the length and depth of a recession and the impact
on market values and prices.

Does Supply And Demand Influence Or Cause A Bear Market?

Since
short supply and increasing demand can send a stock soaring upwards, it
follows that the opposite can be true as well. It is vital to remember
that at the core of this discussion is human nature.

The nature
of the business cycle is one of evolving markets. At times, that
evolution can be pushed too far, too fast. At other times, the reigns
are pulled in and previous gains can be clawed back.

Supply and demand can only describe and explain so much though. There must be, and is, more to it.

The
underlying cause of any bear market is an overvaluation in stocks
relative to their value. As you may have seen from other parts of this
site, companies - and by definition, their stock - can be valued in a
number of ways. These relate to earnings, cash flow, profitability and
much more.

Should prices rise so far that they can no longer be
justified by investors, less investors will be interested in purchasing.
As the underlying value becomes harder to quantify, current stock
holders will be ever more willing to sell and take their profits.

This
combination of holders willing to sell and buyers unwilling to pay the
high prices creates an inbalance in the overall supply and demand of
company stock. When multiplied across an entire sector or market - the
effects can be devastating.

Moving together

A lesson that can be a difficult one for an investor to learn is the extent to which assets are correlated. This means that their prices move (broadly) together. There are some fairly complicated math formulas for all this, but we don't need to go so deep here.

The issue to understand is that many assets will move in price broadly together. This means that the stock markets of different countries will often move in the same direction at the same time. Therefore, having some money in the Dow Jones and some in the FTSE 100 might not be as diversified as you think.

Assets move together because they are impacted by the same things. Thus, the news that makes markets fall in America might have the same impact in Japan. If the news does not impact Japan, then the fact that American prices dropped might have the same effect. Just think what happens when there is a stock market crash!

Additionally, the economic forces that are priced into stock markets can impact different asset classes. For example, it would be unwise to think that if a national economy were in trouble that the stock market would fall but that government and corporate bond prices, residential property values and the national currency's exchange rate will be immune. If things are going well or poorly for the nation, expect lots of assets to move in price.

Clearly, such movements go beyond mere market trends and impact everyone in a country. It can also be the case that a neighbouring nation(s) is impacted (because typically one country will have a majority of it's trade with the countries that are geographically closest to it).

The macro effect

An obvious example of a nation suffering is during a recession. A recession is classed as two consecutive quarters of negative economic growth. Generally, if things are bad, two quarters will be short. An economy is a slow moving thing, like a supertanker, and can take a lot to change course.

If a country is in recession for a number of years, then it is likely that there will be a bear market in a wide variety of assets. These are the hard times for an investor - no matter how and where investments were diversified, they all seem to be falling simultaneously.

However, there is an old investment maxim that is used in both property and stock market investment, "The time to buy is when blood is running in the streets". Having the cash available to pick up those bargains is easier said than done though...

For many of us, it can be tricky to determine just what is going on. The modern news cycle means that channels such as CNN and MSNBC are trying to analyse events minute by minute and this can have a warping effect on opinions. This is especially true since media outlets do everything they can to provide balanced views. This can have the impact of providing a perspective to events that is somewhat fringe.

Personal opinion suggests that the best places for perspective about what is really going on can be found in the Wall Street Journal, the Financial Times and the weekly Economist magazine.

As an investor, it is your job to try and understand the current situation and where the opportunities lie as best you can. If you are a day trader, you need to do this about five times an hour! But for the rest of us that have a longer timeframe, understanding the pattern and general direction ought to be enough.

Hopefully, this goes some way to answering the question posed, "What is a bear market?"